Why I Am Bullish on Husky Energy Inc.

Husky has been maligned by the market for some time, with concerns over startup and execution issues at the Liwan gas project and cost overruns at the Sunrise project. But the integrated energy major has continued to perform strongly, with its growth pillars strategy consistently delivering dividends and unlocking value for the company and its investors.

Here’s why I believe Husky Energy is a solid opportunity for investors.

Citigroup recently rated it a buy

Citigroup recently initiated coverage of the energy company, rating it as a “buy” and setting a $39 price target over the next year, giving investors a potential upside of 21% over that period.

The rationale behind this rating is that in Citigroup’s view Husky appears undervalued compared to its global integrated energy peers. Its globally diversified portfolio of upstream (oil- and gas-producing) assets are complemented by its downstream (refining and marketing) assets, giving it a competitive edge.

Solid portfolio of diverse oil and gas assets helps reduce the impact of softening West Texas Intermediate prices

An appealing aspect of Husky’s operations is its globally diversified portfolio of oil and gas assets, which gives it access to a range of global energy markets, reducing its dependence on U.S. energy markets. This is of growing importance as the U.S. shale oil boom pushes U.S. oil and gas production ever higher, already seeing it outstrip Saudi Arabia to become the world’s largest producer of crude.

It is also flooding North American refining markets with light sweet crude, causing crude prices and in particular West Texas Intermediate, the North American crude benchmark price, to soften in defiance of the usual driver of higher crude prices: growing conflict and geopolitical tensions in the Middle East.

More worrying for Canadian crude producers is that growing U.S. crude production will apply further downward pressure to crude prices, with the expectation that WTI will soften by as much as 10%, or to around $85 per barrel, over the next four years.  This will also see the price differential between WTI and Brent (the key benchmark price for European refining markets) further widen, giving companies with access to Brent pricing an advantage over their peers that don’t.

Because of its diverse asset base, Husky is able to mitigate much of this risk associated with softer WTI prices since this allows it to access a range of energy markets and Brent pricing. This includes its offshore Canadian East Coast crude production, with much of it sold to European energy markets.

Furthermore, despite startup problems at its Liwan gas project, in which Husky  has a 49% interest with the remainder held by China’s CNOOC Ltd., Husky has been able to secure access to mainland China’s energy market with some lucrative pricing contracts for the natural gas sold. These five-year contracts have locked in prices of between $11 and $13 per thousand cubic feet, which is almost triple the current spot price for natural gas. This protects Husky’s revenue from the project against the uncertainties surrounding natural gas prices, which are expected to soften for the foreseeable future and impact on the profitability of those companies with production heavily weighted to natural gas.

Husky also holds a diversified portfolio of oil exploration and development assets including oil sands in onshore Canada, 35% interest in three Flemish Pass basin discoveries in offshore Canada, and a 40% interest in shallow water gas projects in the Madura Strait offshore Indonesia. All of this bodes well for Husky to continue growing oil and gas production while reducing its reliance on U.S. refining markets.

But more importantly, Husky’s downstream business allows it to more effectively manage margins and pricing differentials between crude blends further contributes to its profitability. For all of these reasons, Husky was able to deliver some solid second-quarter 2014 results, where it met expectations, with earnings in line with the consensus analyst forecast of $0.69 per share.

Husky continues to generate a solid operating margin

Husky’s other strength is that it continues to generate a solid margin or netback from its upstream operations, which for the second quarter in 2014 was $48.70 per barrel. This is a healthy 9% increase quarter over quarter and 27% year over year as well as being superior to many of its Canadian peers.

When all of the factors discussed are considered in conjunction with Husky’s juicy 3.7% dividend yield, one of the highest among Canada’s integrated energy majors, and a clearly sustainable 60% payout ratio, the company will continue to reward patient investors while they wait for its share price to appreciate in value.

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Fool contributor Matt Smith has no position in any stocks mentioned.

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